During inflationary times, it can be difficult to know how your savings will be impacted. Matthew Henderson, an investment adviser at Charles Stanley – a UK investment management firm – offers six tips for avoiding the worst of the volatility.
1 Understand how inflation affects you
Henderson explains that inflation is an increase in prices over time, which erodes the spending power of cash – so could be bad news for your savings. As of July 2023, the annual Consumer Price Index inflation rate is 6.8%, meaning cash stashed under a mattress would have lost 6.8% of its purchasing power over the past year. However, it’s never simple. “Inflation isn’t uniform across all goods and services,” Henderson says. While blueberries have decreased by 2% over the past 12 months, the cost of a dozen eggs has gone up by a whopping 27%. “The extent to which you’re personally impacted by inflation depends on your own spending preferences, to a degree.”
2 Avoid cash
While everyone’s level of exposure to inflation varies, there’s one thing that’s true for everyone: holding too much of your savings in cash is a bad idea over the long term. Many cash accounts are currently paying 3% or 4% in interest, which can feel like a good deal, relative to where savings rates have been in the past, but Henderson says: “If you’ve had your cash in a bank account and it’s been receiving 4% interest for the last year, during this time [the year to June 23] inflation has been 7.9%, so in real terms your savings have been eroded by more than 3%.” This is particularly important for pots of money you are unlikely to touch for a long time. “If inflation persists at high levels over the long term it can be really destructive,” he adds. “Even a stable level of inflation of 2% per annum means the general price of goods doubles every 35 years, so the problem is even more evident in periods of high inflation like we are experiencing in the UK currently.” While cash will be needed for short-term emergencies and requirements, it’s wise to put longer-term savings into other assets, such as equities.
3 Explore equities
Equities – shares that represent ownership of a company – offer the possibility of beating inflation. “Companies are one of the mechanisms through which inflation is transmitted,” Henderson says. “During inflationary times, many companies take increasing costs of their raw materials and production and pass these on to their customers by charging higher prices, meaning their earnings can also increase over time.” As a shareholder you are entitled to a claim on these increased earnings.
This is particularly evident if you’re holding the shares of well managed companies that have pricing power. Pricing power can come in a number of forms. “For example, if you’re holding shares in companies that have strong brands to which customers are loyal, then they are often willing to pay for that company’s goods even if they have gone up in price.” Other companies that occupy a market niche, or have a unique product that is sought after by customers will also have pricing power, which can enable them to increase their prices and can lead to their shares also appreciating at a level in line with or ahead of inflation, thus preserving the value of your investment in real terms.
4 Think about your investment horizon
Equities can be a better bet than cash during periods of high inflation, but they’re not without volatility of their own. “It’s not without risk – the stock market goes up and down every day,” Henderson says. “But generally over the long term stock markets appreciate in value. It is therefore important to think about how long you’re able to invest for.” For those investing in the long-term, via a pension for example, it’s likely to be worth taking on equity risk and accepting short term volatility, in the hope of outpacing inflation in the long term. However, if you have a need for your savings imminently – perhaps for a house purchase or another big spend such as a wedding – it can be more prudent to keep your savings in cash.
5 Diversify to reduce risk
There are other risks to equities as well – poorly managed companies can struggle when economic conditions falter. “One way to get around that is to diversify and hold a spread of investments in many different companies, so you don’t have all your eggs in one basket,” Henderson says. “Different companies will behave differently in an inflationary environment.” Commodity companies, for example, will do well in the periods when the raw material they’re producing goes up in price. Some software providers might have a product that is absolutely essential to businesses so might be resilient to inflation. “Customers are happy to pay a higher price, and you can benefit as a shareholder.”
6 Make a plan for challenging times
It is difficult to predict when the next downturn might occur, but it’s safe to assume it will happen at some point. Henderson advises having a plan in place. “What’s really important to think about when you’re saving or investing for the future is when might I need this money back? If you need it back in the short term, you want it to be in more steady investments. That might be cash, it might be short-term bonds.” This can be particularly important for those approaching retirement, who may wish to shift from equities to holding a greater proportion of their savings in bonds and cash.”
What’s critical is to have a plan in place for when difficult times hit. For those who are totally baffled, do not have the time, or who have specific preferences, investment advisers can help them create that plan. Some financial planning topics – particularly pensions – can be complex to tackle, with long-term repercussions if you get it wrong. Advisers have the breadth and depth of knowledge to understand the right questions to ask: the ones where you don’t know what you don’t know.
Asking the right questions, understanding the vision, and devising a road map you can have confidence in, all help to bring you peace of mind, knowing you’ve done all you can to protect and preserve your lifestyle into the future.
If you want to find out how Charles Stanley could help you, request a call back from an adviser.
The value of investments can fall as well as rise. Investors may get back less than invested. Charles Stanley & Co Limited is authorised and regulated by the Financial Conduct Authority.
